Debt is not necessarily a bad thing -- unless you have too much of it. An overload of debt can ruin your financial happiness for years or even decades.
Since the Great Recession that began in 2008, Americans have built up a worrying amount of debt. Recent household debt balances have reached $13.15 trillion, which is now higher than the previous peak debt load in 2008.
It's wise to consider how much your household is contributing to those numbers. Even if there isn't another recession, having an excessive amount of debt is an enormous drain on your financial resources and can make your goals unattainable.
Types of debt
Debt is broken into several distinct categories:
- Mortgages (which represent 67% of the nation’s total debt load)
- Revolving Home Equity debt (4%)
- Auto loans (9%)
- Credit Cards (6%)
- Student Loans (10%)
- Other miscellaneous types of debt (3%)
The good news is that not all debt is bad. "Good" debt is debt that was used to finance something that will increase in value over time.
Mortgages and student loans are widely considered good debt because your house will very likely net you a profit when you sell it, and your education will allow you to earn a higher income over your lifetime.
The bad news is that even good debt can be a problem if you have more of it than you can afford to pay. Buying a house is no longer a good investment if you're forced into bankruptcy and lose the house because you can't pay for it. Excessive mortgage debt was arguably the most significant factor in causing the 2008 recession. When a large enough percentage of households couldn't afford to keep up with their mortgage payments, some of the banks financing those mortgages crumbled and the economy crumbled with them.
Determining your debt percentage
When does debt cross the line and become too much?
It's tough to assign a specific percentage because it depends heavily on your own situation:
- How much income do you earn?
- How much are you devoting to non-debt expenses?
- What are your prospects for the near future?
- Someone heading for a promotion and raise could potentially handle a higher percentage of debt than someone heading for a layoff, for example.
Some financial advisors suggest a 50/30/20 budget: 50% of your income to go toward necessities, 30% toward things you want but don't need, and 20% toward saving money and paying down debt. Ideally, you'll want to squeeze your debt load into that 20% category; if you do so, you likely will be able to keep it under control over time. If your debt grows to the point where you can no longer keep it in the 20% category, you'll have to set aside some of your 30% "wants" budget for extra payments to reduce your total debt.
Sitting down to figure out the percentage of debt you now have can be a tedious and possibly traumatic task. However, you may even be pleasantly surprised to discover that you have less debt than you realized. Once you've added up your debt, you can then figure out how much you need to pay each month to keep it at a comfortable level and still have a little money to put in savings.
Saving can help
Having a fully funded emergency savings account can give you more wiggle room as to how much debt you can handle. If you have an emergency savingsaccount, when an unexpected event happens you can pay for it with your savings instead of putting it on a credit card. So your emergency savings means you don't have to reserve space on credit cards (and in your personal debt budget) to protect you in case of emergency.
At the very least, you'll want enough money in your emergency savings account to cover three months' worth of expenses. Many experts recommend saving enough money for six months to a year of expenses - or even more, in extreme cases.
The amount you should have in emergency savings is another number that will fluctuate based on your personal situation. If you're single with no dependents, successfully employed, and don't have a lot of expenses, you can get by with a relatively small emergency savings account. On the other hand, someone with an iffy job situation and several kids or other dependents will want to have a lot more than three months' worth of expenses saved up.
Your comfort level
The final factor in deciding if your debt load is too high is whether or not you feel comfortable with your current financial situation. Do you feel financially secure? Or do you count the days toward your next paycheck and fret whether there will be enough money to pay for everything? Are you able to regularly set aside money for savings, including retirement savings?
The answers to these questions will tell you if you've overextended on debt. And when it comes to balancing your own household budget, your personal preferences should be the deciding factor.
Genisys Credit Union has teamed up with GreenPath Financial Wellness service. Through our partnership with GreenPath, members enjoy unlimited access to money planning tools and assistance without paying—it's free!
You can receive help with:
- Personal and family budgeting
- Understanding your personal credit report and how to improve your score
- Personal money management
- Debt repayment
- Avoiding bankruptcy, foreclosure, and repossession
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